CBO's Alternatives for Student Loans

After the deadlock last Thursday in the Senate over student loan interest rates, there still appears to be a gap between Democrats and Republicans on how to structure a deal. The July 1 deadline is fast approaching, when the interest rate for subsidized student loans is scheduled to double from 3.4 percent to 6.8 percent. Subsidized loans are meant for undergraduate students who demonstrate financial need, and currently differ not only in the rate but also the fact that interest does not accrue while the student is in school. The House Republicans' bill would charge a market-based interest rate on student loans, while the Senate Democrats' proposal would extend the existing 3.4 percent rate for an additional two years, paid for with farm subsidy cuts and tax increases. President Obama's approach for is similar to the House Republicans but with a different rate. Read more about these three proposals here.

A recent report from the CBO provides numerous alternative ways to deal with student loans, which may help to bridge the gap between the two sides. Under current accounting procedures, CBO estimates that going forward, the student loan program will book a $184 billion profit for the federal government through 2023, since it estimates future returns from the program using a Treasury rate as a discount rate. As Treasury rates rise in the future, that "profit" shrinks as the gap between those rates and student loan rates narrow. However, using fair-value accounting, which incorporates market risk into the discount rate, new lending through 2023 is expected to cost $95 billion, although they will still be profitable for the next two years.

CBO's potential solutions include many market-based solutions, discussed later in the blog, and other policies that include the following:

  • Permanently extend the current rate of 3.4 percent on subsidized loans rather than allowing it to double as scheduled under current law. 
  • Permanently extend the rate on subsidized loans at 3.4 percent and restrict access to subsidized loans to students who are eligible to receive Pell grants.
  • Restrict access to subsidized loans to students who are eligible to receive Pell grants while allowing the interest rate to rise to 6.8 percent.
  • Eliminate the subsidized program all together.

The first option follows the Democrats' proposal (except permanently instead of just for two years) and is estimated to cost $41 billion between 2013 and 2023. The second solution keeps the current 3.4 percent interest rate but restricts access to Pell recipients to mitigate some of the cost. Pairing these two proposals results in a roughly budget-neutral outcome. The third and fourth alternatives both lead to significant savings for the government since they allow the subsidized loan rate to revert to 6.8 percent. Option three involves just restricting eligibility to Pell recipients for savings of $21 billion. The final option would save $49 billion by eliminating subsidized loans entirely, which other than the rate increase would involve students having interest accrue while they were in school. The Bipartisan Path Forward included this policy in its education reforms.

Cost/Savings (-) from Non-Market-Based Student Loan Options/Proposals
  2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2013-2023
Extend 3.4% Rate $2 $4 $4 $4 $4 $4 $4 $4 $4 $4 $4 $41
Extend 3.4% Rate and Tighten Eligibility * * * * * * * * * * * $1
Let Rate Expire and Tighten Eligibility -$1 -$2 -$2 -$2 -$2 -$2 -$2 -$2 -$2 -$2 -$2 -$21
Eliminate Subsidized Loans -$1 -$4 -$5 -$5 -$5 -$5 -$5 -$5 -$5 -$5 -$5 -$49

Source: CBO
*Between -$500 million and $500 million

CBO also shows a number of options for linking student loans to Treasury rates, as the House Republicans and President Obama propose to do. They form a variety of options by a combination of linking to ten-year or one-year Treasuries, adding on 3 or 4 percentage points to the rate, and having the rates capped or uncapped. The first graph shows select options for linking the rates to ten-year Treasury rates, while the second graph shows some one-year Treasury rate options. The ten-year proposals also keep a fixed interest rate throughout the life of the loan, while the one-year rate proposals allow the interest rate to vary each year. As a general rule, ten-year Treasury proposals save more than one-year proposals, uncapped loans save more than capped loans, and (obviously) adding 4 percentage points saves more than adding 3 percentage points.


Source: CBO

With the subsidized loan rates set to rise soon and neither party looking to maintain the status quo, ideally lawmakers will find a permanent solution to the interest rate question. Not only should the cost to the government and the burden on the students be considered, but lawmakers should also put these loans in the context of the greater higher education budget. As we've shown before, some measures designed to promote higher education, particularly provisions in the tax code, could be better designed or replaced with better targeted programs. Hopefully, policymakers can come to a compromise that is both fiscally responsible and helps students fund their educations.